Malaysian companies that were so far not paying withholding tax on income earned in India from technical services will now be subject to the levy, under the revised Double Taxation Avoidance Agreement (DTAA). Indian companies doing business in Malaysia will also have to pay tax there.

Both ways, the companies can claim a set-off in their home country on the taxes paid in the country where the income is generated, that is, the source country. For the Indian government, this could mean a revenue gain as several Malaysian infrastructure majors earn huge incomes on technical services offered for road sector projects.

Malaysian firms, however, are complaining. "The decision threatens the golden quadrilateral project, as large chunks are serviced by these companies," said an infrastructure sector source.

They anticipate an increase in interest costs on borrowings due to the development. Mahaveer C Jain, director, JCSS Consultants, a consulting and regulatory firm, said that Malaysian companies are exempt from tax on foreign income in their home country.

"The withholding tax imposed by India is set to impact their profitability, as unlike in the case of Indian companies, set-offs will not be available to Malaysian companies," he said.

But the DTAA is negotiated between two countries, and the Malaysian government is sure to have considered this aspect.

The revised DTAA with Malaysia has already been approved by the Cabinet. It will be soon notified by the finance ministry, said officials. After the revised treaty comes into force, tax will be withheld for a Malaysian company that provides technical services to an Indian company, either in India or from Malaysia, but does not have a permanent establishment here.

If it does have a PE, its income from such services will be treated as business income. Indications are that the withholding tax rate could be 10%.

Under the existing DTAA with Malaysia, there is no provision for withholding tax on fee for technical services.

But India as a source country wants to have a share of the income earned here by Malaysian companies. This is the reason for incorporating a new clause on withholding tax on fee for technical services like royalty.